The Oil Trader Tug-Of-War

By Tsvetana Paraskova

Despite the recent sell-off, Brent Crude prices continue to be supported by geopolitical events and supply concerns, while the U.S. benchmark WTI Crude has been pressured to the downside by pipeline constraints in the most prolific U.S. shale basin amid record-high American oil production.

The discount of WTI Crude to Brent Crude topped $10 a barrel last week, and even touched $11 a barrel last Thursday. The WTI-Brent spread is currently at its highest since 2015.

The huge discount of the U.S. oil benchmark to the international benchmark is setting the stage for a tug-of-war between oil majors and big oil trading houses that seek to capitalize on the wide price gap to make profitable arbitrage exports of U.S. crude oil on the one hand, and hedge funds and other money managers who bet that WTI will be pushed further into discount.

Hedge funds are betting that the spread will continue to widen, while physical oil traders bet on record U.S. oil export volumes to narrow that gap, brokers and traders tell Bloomberg.

The WTI discount to Brent has doubled from around $5 a barrel in mid-May, while U.S. production continues to break records by the week, and the Permian faces takeaway capacity constraints. The Permian’s production is expected to grow by another 78,000 bpd in June over May, to 3.277 million bpd, EIA estimates show.

But pipeline capacity “may be in short supply over the next year, putting downward pressure on barrels priced in the region and potentially restricting production growth in 2019,” according to Dallas Fed’s Energy Indicators report from May.

“While this is not currently restricting production growth, data suggest that Permian production could exceed transport capacity sometime between mid-2018 and mid-2019 if new pipelines are not brought online,” the Dallas Fed says. Pipeline congestion could become a significant challenge to oil production early next year, especially for smaller producers because larger operators are more likely to have long-term contracts for takeaway capacity, according to the Dallas Fed.

Although it’s not currently restricting growth, pipeline capacity is an issue in the Permian and is expected to further discount WTI prices to Brent.

Commenting on the wide WTI-Brent spread, Andy Lipow, president of Houston-based consultancy Lipow Oil Associates, told the Financial Times: “The market is telling you that the pipelines are full.” “If there was enough pipeline capacity the spread would be no more than the pipeline tariff,” Lipow noted.

The spread is widening even though U.S. crude oil exports are also rising, and recently reached an all-time weekly high of 2.566 million bpd.

“Generally, there should be a fairly linear relationship between U.S. exports and the arbitrage,” Michael Tran, global energy strategist at RBC Capital Markets, told Bloomberg. “But that relationship breaks down as the WTI discount widens to the point where the U.S. can export as much as needed by the broader market.”

Currently, it looks like hedge funds are winning this betting battle, and they are placing bets on widening WTI discount, according to Bloomberg.

The Permian takeaway capacity constraints will get worse before they can get better, with the first of the planned new pipelines expected to come into service in the middle of 2019. Until then, the fastest-growing U.S. oil producing region will have to try to cope with limited takeaway capacity with trucking and crude-by-rail options to ship the oil to pipeline injection points or export terminals.

Yet, trucking and crude-by-rail also have their limitations, according to RBN Energy. Apart from being much more expensive, trucking will require many more drivers who are already in short supply in the Permian. Even if the economics of using alternative takeaway options are justified, both trucking and crude-by-rail will have to compete for tracks, staff, carriages, roads, and drivers with the people and transportation involved in hauling to the Permian the materials being used to produce the crude oil—frac sand, oilfield equipment, fresh water, and produced water, RBN Energy says.

Record U.S. oil exports could ease some of the downward pressure on WTI, but currently, pipeline congestion is the primary factor widening the WTI-Brent spread.

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